On September 13, 2010, the IRS issued its first guidance under section 7701(o), Notice 2010-62, which codifies the economic substance doctrine. The following day, September 14, the IRS issued an Industry Directive that proposed Section 6662 (b)(6) penalties must be reviewed and approved by the appropriate Director of Field Operations. Notice 2010-62 confirms that the government will not provide an angel’s list or entertain private letter ruling requests concerning whether section 7701(o) applies. In addition, Notice 2010-62 provides the following guidance, none of which is surprising or new.  

  • Notice 2010-62 notes that existing case law will apply to determine if a transaction has economic substance and if it has a business purpose.  
  • Because section 7701(o) requires a conjunctive test, the IRS will challenge a taxpayer that applies prior case law to treat a transaction as having economic substance if the case law applies a disjunctive test.  
  • Furthermore, Notice 2010-62 provides that the determination of whether the economic substance test applies to a transaction is made in the same manner as under prior case law.  
  • Moreover, section 7701(o) is relevant only if the economic substance doctrine is relevant.  
  • “Reasonably expected pre-tax profit” requires that the present value of the reasonably expected pre-tax profit is substantial in relation to the present value of the expected net tax benefits applying relevant case law and other published guidance. Although Part II of Notice 98-5, which provided several examples of the application of this test was withdrawn by Notice 2004-19, Notice 2004-19 stated that the IRS would continue to scrutinize abusive transactions that are designed to generate foreign tax credits.  
  • Regulations will be issued that require foreign taxes to be treated as expenses in determining pre-tax profit in appropriate cases. Presumably any regulations would overrule the Compaq and IES cases.  
  • Disclosure requirements (except for reportable transactions) will be met if there is adequate disclosure on a timely filed original return (including extensions) or a qualified amended return under Treas. Reg. §1.664-2(c)(3). Disclosure must be made on a Form 8275 or 8275R in order to be considered adequate.  
  • Comments are requested concerning the disclosure requirements, especially concerning the interplay of Rev. Proc. 94-69, proposed Schedule UTP,) and the compliance assurance process (CAP) program.